The following content was originally published April 2022 on IBM’s Category Insights Newsletter.
During stable market conditions, an effective supplier management plan is essential for successfully completing any construction contract. When markets are as turbulent as they are Today, supplier management is an even greater priority.
In construction, the topic of supplier management often evokes discussions about late completion penalties, but an effective supplier management plan should do more than punish late delivery.
A stick without a carrot
In constrained markets, suppliers have much more latitude about which jobs they will accept and which terms they will be governed by.
When the supply chain has such latitude (and even during times of stability), Owner’s who demand the highest standards of care and want to attract the best Suppliers are best served by more balanced contracts.
A balanced contract will not only disincentivize bad behaviors, it will also incentivize good behaviors.
Contracts that include a late completion penalty should also incentivize early completion.
The value of incentives
The value of the penalty and the value of the bonus should also be balanced. These sums must be significant enough to drive behaviors, but also commensurate with the value of the project. This statement is true at both extremes.
Owner’s often want to include lost profits in their penalties which can drive the value of a penalty way above the value of the contract. Not only would penalties of such magnitude be considered punitive, it’s also widely held that lost profits cannot be included in penalties.
Penalties should be a sum derived from estimates of the actual expenses a company would incur because of a late completion. If actual expenses cannot be calculated the penalty can be a percentage of the contract value.
On the flip side, Supplier incentives should be of equal to or of proximate value to the penalty. Of course the Owner must be able to derive value from an early completion of the project, otherwise, neither a bonus nor a penalty should be considered.
Schedule is not the ONLY thing
Supplier performance is about more than just timely completion.
Other factors such as safety can be more valuable than schedule, but most Owners fail to address these in their contracts.
One of the greatest risks to any construction project is the risk of jobsite injuries. Regardless of how large or small a project may be and regardless of what insurances and policies may be in place, Owners are always implicated in jobsite injury claims. For that reason, incentives that promote jobsite safety can be even more valuable than incentives for early completion, yet very few contracts ever incentivize safety.
Even contracts with shared savings provisions should include safety targets as a pre-requisite for securing any shared savings benefits. Afterall, why would you reward a supplier for achieving savings or improving on schedule if they failed to protect workers?❖
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